Regulators propose easing of margin payments for non-cleared swaps

The latest consultation from global regulatory bodies on the margin required for non-cleared swaps appears to ease collateral concerns and allow for a long-dated implementation period.

The joint consultation paper from the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) has been described as a “near-final proposal”.

Under the proposals, the first €50 million of collateral required for bilaterally-traded derivatives would be waived. The threshold would be applied for the combined exposure of all a firm’s affiliates against positions held with a counterparty and its subsidiaries. The latest proposal also recommends a four-year phase-in period for when initial margin should be collected, starting with the largest, most active and most systemically risky swap market participants from 2015.

According to a quantitative impact study by IOSCO and BCBS, the €50 million threshold will reduce overall collateral costs by 56% compared to its initial consultation in July 2012, which included no such threshold.

The regulators’ latest approach to initial margin addresses industry-wide concerns on the expected collateral shortfall stemming from the need to hold more margin against all swaps positions as per the new rules.

Historically, the buy-side has not paid any initial margin against OTC derivatives positions and variation margin – collateral that reflects the change in an instrument’s valuation over its lifetime – was informally managed. New swaps rules will require OTC derivatives that can be standardised to be traded on exchange-like platforms and centrally cleared, requiring more formalised margin payments.

Responding to the last BCBS-IOSCO consultation, trade bodies – the International Swaps and Derivatives Association (ISDA), the Institute of International Finance (IIF) and the Association for Financial Markets in Europe (AFME) – warned the imposition of initial margin for non-cleared swaps would have a ‘severe’ impact on liquidity.

“Adding mandatory initial margin could increase rather than decrease systemic risk and harm liquidity in vital markets,” read the trade bodies joint response to the last consultation on margin in December 2012.

However, ISDA, AFME and IIF also questioned the benefit of the phase-in approach in their December submission.

“The reality is that a phase-in approach would not alter the extremely deleterious impact the initial margin requirements would have on uncleared OTC derivatives. Nor…would it enable market participants to transition to other alternatives to non-standard, custom-tailored and uncleared OTC derivatives. Such alternatives do not exist,” read the response.

Market participants will have until 15 March to submit their comments to BCBS and IOSCO, after which the bodies will work to finalise their proposals.